##### Table of Contents

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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





(Mark One)


|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|--- |  | ---------------------------------------------------------------------------------------




For the quarterly period ended June 30, 2002





OR





| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




For the transition period from  to
 .





Commission File No.: 0-33213





---




MAGMA DESIGN AUTOMATION, INC.


(Exact name of registrant as specified in its charter)





Delaware

77-0454924(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification Number)





2 Results Way


Cupertino, California 95014


(Address of principal executive offices)





Telephone: (408) 864-2000


(Registrants
telephone number, including area code)





---




Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes  x  No  ̈





On August 12, 2002,
30,556,856 shares of Registrants Common Stock, $.0001 par value were outstanding.





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##### Table of Contents




MAGMA DESIGN AUTOMATION, INC.





FORM 10-Q





QUARTERLY PERIOD ENDED JUNE 30, 2002





INDEX





PagePart I: Financial Information

1Item 1: Financial Statements

1Unaudited Condensed Consolidated Balance Sheets at June 30, 2002 and March 31, 2002

1Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2002 and 2001

2Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2002 and 2001

3Notes to Unaudited Condensed Consolidated Financial Statements

4Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations

8Item 3: Quantitative and Qualitative Disclosures About Market Risk

24Part II: Other Information

25Item 1: Legal Proceedings

25Item 5: Other Information

25Item 6: Exhibits and Reports on Form 8-K

25Signatures

27Exhibit Index

28




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##### Table of Contents




PART I:    FINANCIAL INFORMATION





Item 1:Financial Statements


|
|

MAGMA DESIGN AUTOMATION, INC.





UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands)





June 30, 2002


March 31, 2002(unaudited)ASSETSCurrent assets:Cash and cash equivalents

$
90,289


$
78,478Short-term investments






13,468Accounts receivable, net


15,923



17,601Prepaid expenses and other current assets


1,686



1,327Total current assets


107,898



110,874Property and equipment, net


7,396



7,252Other assets


1,976



1,583Total assets

$
117,270


$
119,709LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
2,694


$
1,777Accrued expenses


5,974



9,441Deferred revenue


12,404



15,617Total current liabilities


21,072



26,835Other long-term liabilities


120



130Total liabilities


21,192



26,965Commitments and contingencyStockholders equity:Preferred stock, $.0001 par value; 5,000,000 shares authorized and no shares issued and outstanding






Common stock, $.0001 par value; 150,000,000 shares authorized and 30,443,814 and 30,239,786 shares issued and
outstanding at June 30, 2002 and March 31, 2002, respectively


3



3Additional paid-in capital


224,772



223,450Deferred stock-based compensation


(4,945
)


(7,161
)Notes receivable from stockholders


(2,342
)


(1,936
)Accumulated other comprehensive income


144



Accumulated deficit


(121,554
)


(121,612
)Total stockholders equity


96,078



92,744Total liabilities and stockholders equity

$
117,270


$
109,709





See accompanying notes to unaudited condensed consolidated financial
statements.




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##### Table of Contents

MAGMA DESIGN AUTOMATION, INC.





UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


(in thousands, except per share data)


(unaudited)





Three Months Ended June
30,2002


2001Revenue:Licenses

$
13,377


$
5,369Services


4,746



1,237Total revenue


18,123



6,606Cost of revenue


2,793



1,779Gross profit


15,330



4,827Operating expenses:Research and development


5,337



4,629Sales and marketing


6,037



5,348General and administrative


2,225



1,527Amortization of stock-based compensation*


1,901



1,099Total operating expenses


15,500



12,603Operating loss


(170
)


(7,776
)Interest income (expense):Interest income


433



43Interest expense


(2
)


(44
)Interest income (expense), net


431



(1
)Net income (loss) before income taxes


261



(7,777
)Income taxes


(203
)


(20
)Net income (loss)

$
58


$
(7,797
)Net income (loss) per common share:Basic

$
0.00


$
(0.76
)Diluted

$
0.00


$
(0.76
)Weighted average shares:Basic


29,828



10,251Diluted


32,802



10,251*    Components of stock-based compensation amortization are as follows:Cost of revenue

$
20


$
10Research and development


399



240Sales and marketing


758



261General and administrative


724



588$
1,901


$
1,099





See accompanying notes to unaudited condensed consolidated financial
statements.




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##### Table of Contents

MAGMA DESIGN AUTOMATION, INC.





UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands, unaudited)





Three Months Ended June 30,2002


2001Cash flows from operating activities:Net income (loss)

$
58


$
(7,797
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


1,198



1,061Provision for doubtful accounts


300



Interest income on note receivable from stockholders


(68
)


(2
)Amortization of stock-based compensation


1,901



1,099Change in operating assets and liabilities:Accounts receivable


1,378



900Prepaid expenses and other current assets


(359
)


(84
)Accounts payable


917



64Accrued expenses


(3,467
)


10Deferred revenue


(3,213
)


2,007Other long-term liabilities


(10
)


9Net cash used in operating activities


(1,365
)


(2,733
)Cash flows from investing activities:Purchase of property and equipment


(1,342
)


(771
)Proceeds from the sale of short-term investments


13,468



Other assets


(393
)


83Net cash provided by (used in) investing activities


11,733



(688
)Cash flows from financing activities:Proceeds from issuance of preferred stock






5Proceeds from issuance of common stock


1,299



60Repurchase of subsidiary stock






(402
)Repurchase of common stock






(13
)Repayment of notes payable to bank






(332
)Net cash provided by (used in) financing activities


1,299



(682
)Effect of exchange rate changes on cash and cash equivalents


144



Increase (decrease) in cash and cash equivalents


11,811



(4,103
)Cash and cash equivalents at beginning of period


78,478



14,713Cash and cash equivalents at end of period

$
90,289


$
10,610Supplemental disclosure:Non-cash investing and financing activities:Deferred stock based compensation

$
(23
)

$
643Cash paid for:Interest

$
2


$
44Taxes

$
203


$
20





See accompanying notes to unaudited condensed consolidated financial
statements.




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##### Table of Contents




MAGMA DESIGN AUTOMATION, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





Note 1.    The Company and Summary of Significant Accounting Policies





Basis of Presentation





The interim condensed consolidated financial statements included herein have been prepared by Magma Design Automation, Inc. (Magma or the Company) without audit, pursuant to the
rules and regulations of the United States Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted. The interim condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary (consisting only of normal recurring adjustments) to
present a fair statement of results for the interim periods presented. The operating results for any interim period are not necessarily indicative of the results that may be expected for the entire fiscal year ending March 31, 2003. The accompanying
condensed consolidated financial statements should be read in conjunction with the Companys Form 10-K, as filed with the SEC on June 28, 2002. The accompanying condensed consolidated balance sheet at March 31, 2002 is derived from audited
consolidated financial statements at that date.





Use of estimates





Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period. Management periodically evaluates such estimates and assumptions for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon
such periodic evaluation. Actual results could differ from those estimates.





Reclassifications





Certain amounts in the fiscal 2002 condensed consolidated financial statements have been reclassified to
conform to the fiscal 2003 presentation.





Unbilled receivables





The Company considers unbilled receivables to be revenue that has been recognized in the financial statements, but has not been invoiced
to the customer. As of June 30, 2002 and March 31, 2002, unbilled receivables were approximately $2.6 million and $2.1 million, respectively and are included in accounts receivable on the accompanying condensed consolidated balance sheets.





Allowance for doubtful accounts





The Company evaluates collectibility of trade receivables based upon analysis of specific accounts. When management becomes aware of a customers inability to pay,
such as in the case of bankruptcy or a decline in the customers operating results or financial position, the Company records a specific reserve for bad debt to reduce the related receivable to an amount believed to be collectible. As of June
30, 2002 and March 31, 2002, allowance for doubtful accounts was $400,000 and $100,000, respectively.





Cash
equivalents and short-term investments





The Company considers all highly liquid investments purchased with
remaining maturities of three months or less to be cash equivalents. As of June 30, 2002 and March 31, 2002, cash equivalents consisted primarily of commercial paper and money market funds.




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Restricted Cash





Included in other non-current assets on the condensed consolidated balance sheets at June 30, 2002 and March 31, 2002 is restricted cash of $517,000 and $564,000,
respectively, to support letters of credit as security deposits on leased facilities. The deposits are required for the three-year and five-year terms of the leases.





Foreign currency





The
financial statements of foreign subsidiaries are measured using the local currency of the subsidiary as the functional currency. Accordingly, assets and liabilities of the subsidiaries are translated at current rates of exchange at the balance sheet
date, and all revenue and expense items are translated using weighted-average exchange rates for the period. Prior to the quarter ended June 30, 2002, the resultant gains or losses from translation were not significant. Beginning in the quarter
ended June 30, 2002, resultant gains or losses from translation were classified as a component of accumulated other comprehensive income within stockholders equity in the condensed consolidated balance sheets.





Comprehensive Income (Loss)





Comprehensive income (loss) includes net income (loss) and foreign currency translation adjustments as follows (in thousands):





Three Months Ended June 30,2002

2001Net income (loss)

$
58


(7,797
)Foreign currency translation adjustments


144


$
202

$
(7,797
)





Recently issued accounting pronouncements





In October 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS 144 supersedes SFAS 121,
Accounting for Impairment or Disposal of Long-Lived Assets, it retains many of the fundamental provisions of SFAS 121. SFAS 144 also supersedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting
the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30), for the disposal of a segment of a business. However,
it retains the requirement in APB 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held
for sale. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Companys adoption of SFAS 144 effective April 1, 2002 did not have a material effect on its condensed
consolidated financial statements.





In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements
4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections Business Combinations. The provisions of SFAS 145, related to the rescission of SFAS 4, are effective for fiscal years beginning after May 15, 2002, and the provisions
related to SFAS 13 are effective for transactions occurring after May 15, 2002. SFAS 145 rescinds SFAS 4, Reporting Gains and Losses from Extinguishment of Debt, SFAS 64, Extinguishment of Debt Made to Satisfy Sinking-Fund
Requirements, and SFAS 44, Accounting for Intangible Assets of Motor Carriers. SFAS 145 also amends SFAS 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed conditions. The Company does not expect the adoption to have a material impact on its condensed consolidated financial statements.





In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses
costs associated with an exit activity (including restructuring) or with disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities and
personnel. The provisions of SFAS 146 will not supersede the accounting requirements for costs to restructure operations




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acquired in a business combination. Under SFAS 146, a company will record a liability for a cost associated with an exit or disposal activity
when that liability is incurred and can be measured at fair value. The new requirements are effective prospectively for exit and disposal activities initiated after December 31, 2002. A company may not restate its previously issued financial
statements. SFAS 146 also grandfathers the accounting for liabilities that a company had previously recorded under Emerging Issues Task Force Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit
and Activity (Including Certain Costs Incurred in a Restructuring). The Company will adopt SFAS 146 effective January 1, 2003 and does not expect the adoption to have a material impact on its condensed consolidated financial statements.





Note 2.    Basic and Diluted Net Loss Per Share





The Company computes net loss per share in accordance with SFAS 128, Earnings per Share. Basic net loss per share is computed by dividing net loss available to
common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted net loss per share gives effect to all dilutive potential common shares outstanding during the period including
stock options and warrants using the treasury stock method and preferred stock using the if-converted method. The diluted net loss per share is the same as the basic net loss per share for the period ended June 30, 2001 because potential common
shares, composed of common stock issuable upon exercise of stock options and warrants and upon conversion of preferred stock, are not considered when their effect is antidilutive.





The following potential common shares have been excluded from the computation of diluted net loss per share for the three months ended June 30, 2001 because their effect
would have been antidilutive:





Shares issuable under stock option plans

3,701,610Shares of common stock issued pursuant to stock option plans and subject to repurchase

476,346Shares of common stock purchased by founders and subject to repurchase

209,643Shares of preferred stock on an as if converted basis

9,186,176Shares issuable pursuant to warrants to purchase preferred stock

239,617





As of June 30, 2001, the weighted-average exercise price of stock
options outstanding was $8.092, the weighted average repurchase price of common stock issued pursuant to stock option plans outstanding was $0.452, and the weighted-average repurchase prices of founders common stock outstanding was $.00117.





Note 3.    Contingency





The Company is a defendant in a lawsuit alleging breach of contract, fraud and deceit, unfair business practices and intentional interference with prospective economic
advantage arising out of an OEM distribution agreement. The complaint, filed in August 2001, seeks damages of $3.15 million as well as other damages from any gains, profits and advantages lost and punitive damages. The Company filed a
cross-complaint against the plaintiff in December 2001, alleging breach of contract, breach of implied covenant of good faith and fair dealing, breach of express warranty and negligent misrepresentation. On May 15, 2002, the plaintiff amended its
complaint to include allegations of defamation, trade libel, and intentional and negligent interference with prospective economic advantage. These allegations are brought against the Company, its Chief Executive Officer, and other Doe
defendants. In addition, the plaintiffs amended complaint adds allegations of promissory fraud and concealment to the claims against the Company. In addition to the damages sought in connection with the original complaint, the amended
complaint seeks damages of not less than $14.7 million in connection with the plaintiffs lost sales and services opportunities and not less than $88 million in connection with the plaintiffs lost acquisition opportunities. On June 19,
2002, the Company filed a demurrer in response to the amended complaint on the grounds that the plaintiff failed to state a claim for fraud, interference with prospective economic advantage, defamation and trade libel. Following a hearing on August
6, 2002, the Court sustained the Companys demurrer on seven of the eight causes of action at issue, including intentional misrepresentation, promissory fraud, intentional and negligent interference with economic advantage, defamation and trade
libel. The Court overruled the demurrer as to one claim against the Company for fraudulent concealment. If the plaintiff does not file its second amended complaint by August 29, 2002, then seven claims at issue will be dismissed from the lawsuit.
The Company intends to vigorously defend itself against all of the plaintiffs allegations, including the most recent claims. No estimate of a loss or range of loss upon resolution of the lawsuit can be made at this time.





The Company may be subject to various other claims and legal actions arising in the ordinary course of business.




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Note 4.    Segment Information





The Company has adopted the provisions of SFAS 131, Disclosures about Segments of an Enterprise and Related Information, which
requires the reporting of segment information using the management approach. Under this approach, operating segments are identified in substantially the same manner as they are reported internally and used by the Companys chief
operating decision maker (CODM) for purposes of evaluating performance and allocating resources. Based on this approach, the Company has one reportable segment as the CODM reviews financial information on a basis consistent with that
presented in the condensed consolidated financial statements.





Revenue for the three months ended June 30, 2002
was comprised of $12,561,000, $3,035,000, $2,075,000 and $452,000 from the United States, Europe, Japan, and Asia-Pacific region, respectively. The Asia-Pacific region includes India, South Korea, Taiwan, Hong Kong and the Peoples Republic of
China. Revenue for the three months ended June 30, 2001 was comprised of $3,980,000, $1,015,000, $1,611,000 and $0 from the United States, Europe, Japan and Asia-Pacific region, respectively.





Revenue attributable to significant customers, representing 10% or more of total revenue for at least one of the respective periods, are summarized as follows:





Three Months Ended June 30,2002


2001Customer A

6
%

11
%Customer B

13


5Customer C

5


11Customer D

7


16Customer E

11


12





The Companys revenue was derived from the following products
and services (in thousands):





Three Months Ended June 30,2002

2001Design and implementation software products

$
13,250


5,276Analysis and verification software products


127


93Software maintenance and consulting


4,746


1,237$
18,123

$
6,606




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Item 2:Managements Discussion and Analysis of Financial Condition and Results of Operations





This Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited condensed consolidated
financial statements and notes thereto set forth in Item 1 of this report and the section entitled Managements Discussion and Analysis of Financial Condition and Results of Operations in the Companys Annual Report on Form
10-K for the year ended March 31, 2002.





When used in this discussion, the words expects,
anticipates, believes, estimates and similar expressions are intended to identify forward-looking statements. These statements, which include statements as to anticipated sources of revenue, including Blast Fusion
and related products accounting for most of our revenue for the foreseeable future, decreasing revenues from Moscape products, increases or decreases in the cost of revenue in absolute dollars and as a percentage of revenue, our support of current
customers utilizing Moscape products, expectations regarding the terms of future license agreements, decreases or increases in our operating expenditures in absolute dollars or as a percentage of revenue, anticipated expansion of our customer base
and the number and amount of our license agreements, increases in our capital expenditures and lease commitments, anticipated growth in operations, infrastructure and personnel, the integration of GateScope technology into our other products,
amortization of deferred stock-based compensation, our litigation strategy, the adequacy of our capital resources, the adoption of recent accounting pronouncements, our anticipated business growth, our profitability, our reliance on a small number
of customers, expansion of international operations and the geographic scope of our operations, adequacy of office space, our sales efforts, potential acquisitions or business combinations, our intellectual property strategy, our competitors and the
effects of consolidation in our target markets, fluctuations in the price our of common stock, adequacy of our capital resources, and the effects of market interest rates on our investments, are subject to risks and uncertainties that could cause
actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as risks relating the loss of a significant customer, customers not adopting new products,
unanticipated expenditures, terrorist attacks and increased international tensions including in the Middle East, expenses related to litigation, market fluctuations, our inability to integrate acquired businesses, consolidation in our industry,
fluctuations of foreign currencies, and the matters discussed in Factors That May Affect Our Results. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based.





Overview





We provide design and implementation software that enables chip designers to reduce the time it takes to design and produce complex deep submicron integrated circuits used in the communications, computing, consumer electronics,
networking and semiconductor industries. We were incorporated in Delaware in April 1997, and through the quarter ended December 31, 1999, we were primarily engaged in development stage activities, including developing our technology and products,
recruiting personnel and raising capital. In April 1999, we shipped the first version of our initial product, Blast Fusion. In May 2000, we began shipping Blast Chip, which extends the capabilities of Blast Fusion by adding RTL synthesis. In
September 2001, we began shipping Blast Plan, which enables hierarchical planning and partitioning of a design into large blocks that can be implemented individually and later assembled to create a complex chip or system-on-a-chip. In January 2002,
we began shipping Diamond SI, a post layout verification tool based in part on technology obtained through our merger with Moscape.





Sources of Revenue





We generate revenue from two sources: software licenses and services.
We derive software license revenue from our design and implementation software products, which include Blast Fusion, Blast Chip, and Blast Plan. We have generated revenue from our analysis and verification software products, Blast Noise,
CircuitScope, GateScope, and most recently Diamond SI. We have discontinued the development, marketing and licensing of CircuitScope and are not actively marketing GateScope. However, our new Diamond SI product is based in part on Moscapes
GateScope technology. Diamond SI is a stand-alone system and is suitable for use with either Magma or non-Magma chip design flows.




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We derive services revenue primarily from:





| |  |  | consulting, training and maintenance for our design and implementation software products; and
| | - |  | ---------------------------------------------------------------------------------------------




| |  |  | maintenance revenue from our analysis and verification software products.
| | - |  | -------------------------------------------------------------------------




Our standard perpetual license agreement and our time-based unbundled license agreements include maintenance, generally for a one-year period.





Critical Accounting Policies and Estimates





We consider the following accounting policies related to revenue recognition, allowance for doubtful accounts and contingencies to be critical policies due to the estimation processes involved in each.





Revenue Recognition





We recognize revenue in accordance with Statement of Position (SOP) 97-2, as modified by SOP 98-9. SOP 97-2, as modified, generally requires revenue earned on software arrangements
involving multiple elements such as software products, upgrades, enhancements, maintenance, installation and training to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on
evidence that is specific to the vendor. If evidence of fair value does not exist for all elements of a license agreement and maintenance is the only undelivered element, then all revenue for the license arrangement is recognized ratably over the
term of the agreement. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of
the undelivered elements is deferred and the remaining portion of the license fee is recognized as revenue.





License revenue





We derive license revenue primarily from our design and implementation
software and, to a much lesser extent, from our analysis and verification products. Through June 30, 2001, we licensed our design and implementation software products only under time-based licenses. Beginning in the quarter ended September 30, 2001,
we also began licensing these products under perpetual licenses as we expanded our customer base generally to include smaller companies and companies requiring fewer licenses. We license our analysis and verification software products primarily
under perpetual licenses.





License revenue is recognized after the execution of a license agreement and the
delivery of the product to the customer, provided that there are no uncertainties surrounding the product acceptance, fees are fixed and determinable, collectibility is probable and there are no remaining obligations other than maintenance. For
licenses where vendor specific objective evidence of fair value (VSOE) for maintenance exists, license revenue is recognized up front using the residual method. As a result, license revenue is recognized in the period in which the
license agreement is executed assuming all other revenue recognition criteria are met. For licenses where VSOE for maintenance does not exist, license revenue is recognized ratably over the maintenance term.





Prior to June 30, 2001, we bundled maintenance into our time-based license agreements for our design and implementation software products
for the entire license term, and consequently VSOE of fair value did not exist for each element of the arrangement. For our bundled license agreements, where the only undelivered element is maintenance, we recognize revenue ratably over the contract
term. If an arrangement involves extended payment terms, that is, where less than 80% is due in one year from the contract date, we recognize revenue to the extent of the lesser of the portion of the fee presently due and payable or the ratable
portion of the entire fee. These revenue recognition practices apply to bundled license agreements entered into both before and after June 30, 2001.





In addition to continuing to offer time-based licenses bundled with maintenance, starting in the quarter ended September 30, 2001, we unbundled maintenance from some of our time-based licenses by
including maintenance for only the first year of the license term. Thereafter, maintenance on these agreements can be renewed by the customer at the rate stated in the agreements. In these unbundled licenses, the aggregate renewal period is greater
than the initial bundled maintenance period. The renewal rate is VSOE of the fair value of maintenance; and maintenance on our perpetual licenses is required for the first year. Thereafter, maintenance on these agreements can be renewed by the
customer at the rate stated in the agreements. The




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renewal rate is VSOE of maintenance; therefore, where the only undelivered element is maintenance, we recognize license revenue using the residual method. If an arrangement involves extended
payment terms, revenue recognized using the residual method is limited to amounts due and payable.





Services
revenue





We derive services revenue primarily from consulting and training for our design and implementation
software products and from maintenance provided under our unbundled time-based and perpetual license agreements for our design and implementation software products, and to a lesser extent from maintenance of our analysis and verification software
products. Our standard perpetual license agreement and our unbundled license agreements include maintenance, generally for a one-year period. Services revenue from maintenance arrangements is recognized on a straight-line basis over the maintenance
term. After the initial maintenance term, maintenance can be renewed annually at the renewal rate specified in the agreement. Because we have VSOE of fair value for consulting and training services, revenue is recognized when these services are
delivered.





Allowance for doubtful accounts





Management specifically analyzes accounts receivable, customer creditworthiness, current economic trends and changes in customer payment patterns when evaluating the
adequacy of the allowance for doubtful accounts in any accounting period. The allowances reflect our best estimate as of the reporting dates. Changes may occur in the future, which may make us reassess the collectibility of amounts and at which time
we may need to provide additional allowances in excess of that currently provided.





Contingencies





Because we are subject to proceedings, lawsuits and other claims, we are required to assess the likelihood of
any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of accruals required, if any, for these contingencies is made after careful analysis of each individual issue.




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Results of Operations





The following table sets forth, for the periods indicated, certain financial data as a percentage of total revenue:





Three Months Ended June 30,2002


2001Revenue:Licenses

74
%

81
%Services

26


19Total revenue

100


100Cost of revenue

15


27Gross margin

85


73Operating expenses:Research and development

30


70Sales and marketing

33


81General and administrative

12


23Amortization of stock-based compensation

11


17Total operating expenses

86


191Operating loss

(1
)

(117
)Interest income (expense), net

2


0Net income (loss) before income taxes

1


(117
)Income taxes

(1
)

(1
)Net (income) loss

0
%

(118
)%





Revenue





Revenue increased from $6.6 million for the three months ended June 30, 2001 to $18.1 million, or 174%, for the three months ended June
30, 2002. Of the $18.1 million of revenue recognized during the three months ended June 30, 2002, approximately $13.4 million is license revenue. While to date we have focused primarily on time-based license agreements on which revenue has been
recognized ratably, we also began to enter into perpetual licenses and unbundled time-based license agreements during the quarter ended September 30, 2001. For the three months ended June 30, 2002, revenue from our ratable time-based licenses
accounted for approximately 83% of our total revenue, and revenue from our perpetual and our unbundled time-based license agreements accounted for approximately 17% of our total revenue. Although we plan to enter into both unbundled and ratable
time-based license agreements and perpetual license agreements in the future, we expect to derive the majority of our revenue in the foreseeable future from ratable time-based license agreements.





License revenue





License
revenue increased from $5.4 million for the three months ended June 30, 2001 to $13.4 million or 149% for the three months ended June 30, 2002. This increase was primarily due to an increase in license revenue from our design and implementation
software products, specifically from Blast Fusion and to a lesser extent from Blast Chip. In addition, beginning in the quarter ended September 30, 2001, we began to recognize revenue under perpetual and unbundled time-based license agreements using
the residual method under which revenue is recognized more rapidly. For the three months ended June 30, 2002, $2.9 million was derived from perpetual licenses and $0.2 million was derived from unbundled time-based license agreements using the
residual method. The ratio between ratable time-based license and perpetual license revenue may fluctuate on a quarter to quarter basis.





Services revenue





Services revenue increased from $1.2
million for the three months ended June 30, 2001 to $4.7 million or 284% for the three months ended June 30, 2002. This increase was primarily due to consulting services provided to licensees of our design and implementation software products.
Although we intend to continue to offer these consulting services, we expect




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consulting service revenue as a percent of total revenue to decrease both in the short-term and long-term. The ratio between license revenue and service revenue may fluctuate on a quarter to
quarter basis.





Cost of Revenue





Cost of revenue consists primarily of cost of license revenue and, to a lesser extent, cost of consulting services for our design and implementation software products. Cost
of revenue, as just described, consists primarily of salary and related costs for engineers associated with technical services, including quality assurance, and cost of engineers associated with post-contract customer support and consulting
services. To date, the cost of service revenue for analysis and verification products has been insignificant. Cost of revenue increased from $1.8 million or 27% of total revenue for the three months ended June 30, 2001 compared to $2.8 million or
15% of total revenue for the three months ended June 30, 2002. This increase in absolute dollars is primarily due to costs associated with additional support required by our expanding customer base combined with costs related to increased design
services. While we expect cost of revenue to increase in absolute dollars, we also expect the cost as a percentage of revenue will decline in relation to our anticipated business growth.





Operating Expenses





Research and development





Research and development expense consists primarily of
salaries, bonuses and benefits of engineering personnel, depreciation of engineering equipment, and outside engineering services from contractors and consultants. Research and development expense increased from $4.6 million or 70% of total revenue
for the three months ended June 30, 2001 to $5.3 million or 30% of total revenue for the three months ended June 30, 2002. This increase was primarily due to increases of $0.4 million in outside service expense and $0.5 million in payroll related
expenses due to an increase in personnel. Development costs incurred in the research and development of new technology and enhancements to existing technology are expensed as incurred until technological feasibility in the form of a working model
has been established. To date, capitalized costs for our software development have not been material. We expect research and development expense to increase in absolute dollars as we improve our current products and develop new products and services
but to continue to decrease as a percentage of total revenue over time. In addition, we expect research and redevelopment expense as a percentage of revenue to fluctuate quarter to quarter.





Sales and marketing





Sales and marketing expense consists primarily of salaries, sales commissions, bonuses, benefits and related costs of sales and marketing personnel, tradeshows and other marketing activities. Sales and marketing expense
increased from $5.3 million or 81% of total revenue for the three months ended June 30, 2001 to $6.0 million or 33% of total revenue for the three months ended June 30, 2002. The increase was primarily due to an increase in payroll related expenses
of $0.8 million and the impact of a reversal in the first quarter of last fiscal year of $0.7 million in accrued commissions (resulting from the termination of a distribution arrangement), partially offset by a reduction of $0.9 million in
commission expense and a reduction of $0.1 million in outside services. We expect sales and marketing expense to increase in absolute dollars in connection with the anticipated expansion of our customer base and the number and amount of our license
agreements. We also expect sales and marketing expense as a percentage of total revenue to continue to decrease over time. In addition, we expect sales and marketing expense as a percentage of revenue to fluctuate quarter to quarter.





General and administrative





General and administrative expense consists primarily of salaries, bonuses, benefits and related costs of finance and administrative personnel and outside service expenses
including legal, accounting and recruiting services. General and administrative expense increased from $1.5 million or 23% of total revenue for the three months ended June 30, 2001 to $2.2 million or 12% of total revenue for the three months ended
June 30, 2002. Of the net increase of $0.7 million, outside services increased by $0.4 million, insurance expense increased by $0.1 million, and bad debt expense increased by $0.3 million. These increased costs were partially offset by a decrease of
$0.2 million in bonuses. We expect general and administrative expense to increase in absolute dollars. We also expect general and administrative expense as a percentage of total revenue to continue to decrease over time. In addition, we expect
general and administrative expense to fluctuate quarter to quarter.




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Amortization of stock based compensation





Stock-based compensation expense consists of the amortization of deferred stock-based compensation
resulting from the grant of stock options at exercise prices less than the fair value of the underlying common stock on the grant date for officers and employees and the fair value of the stock options granted to consultants. The options generally
vest over four years, with 25% vesting after one year and then ratably over the remaining 36 months. Amortization of stock-based compensation was $1.9 million or 11% of total revenue for the three months ended June 30, 2002 and $1.1 million or 17%
of total revenue for the three months ended June 30, 2001. The increase is primarily due to amortization of $0.4 million for options granted after June 30, 2001 and amortization of $0.4 million related to options granted to our President and Vice
President of Sales in November 2001.





Interest Income (Expense), Net





Interest income (expense), net was $431,000 for the three months ended June 30, 2002 and $(1,000) for the three months ended June 30,
2001. Interest income increased from $43,000 for the three months ended June 30, 2001 to $433,000 for the three months ended June 30, 2002 due to a significant increase in cash and cash equivalents primarily from our IPO. Interest expense decreased
from $44,000 for the three months ended June 30, 2001 to $2,000 for the three months ended June 30, 2002. This decrease was primarily attributable to our repayment of notes payable that occurred in November of 2001.





Income Taxes





From inception through June 30, 2002, we incurred net losses for federal and state tax purposes and have not recognized any tax benefit. We are in a net deferred tax asset position, which has been fully reserved. We will
continue to provide a valuation allowance for our net deferred tax assets until it becomes more likely than not that the net deferred tax assets will be realized. For the three months ended June 30, 2002, we had a provision for income taxes of $0.2
million, which consisted of $141,000 for domestic taxes and $62,000 for foreign taxes.





Certification by Chief Executive Officer and
Chief Financial Officer





The certification by the Companys chief executive officer and chief financial
officer of this report on Form 10-Q, as required by section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350), has been submitted to the Securities and Exchange Commission as additional correspondence accompanying this report.





Legal Matters





We are a defendant in a lawsuit alleging breach of contract, fraud and deceit, unfair business practices and intentional interference with prospective economic advantage arising out of an OEM distribution agreement. The
complaint, filed in August 2001, seeks damages of $3.15 million as well as other damages from any gains, profits and advantages lost and punitive damages. We filed a cross-complaint against the plaintiff in December 2001, alleging breach of
contract, breach of implied covenant of good faith and fair dealing, breach of express warranty and negligent misrepresentation. On May 15, 2002, the plaintiff amended its complaint to include allegations of defamation, trade libel, and intentional
and negligent interference with prospective economic advantage. These allegations are brought against us, our Chief Executive Officer, and other Doe defendants. In addition, the plaintiffs amended complaint adds allegations of
promissory fraud and concealment to the claims against us. In addition to the damages sought in connection with the original complaint, the amended complaint seeks damages of not less than $14.7 million in connection with the plaintiffs lost
sales and services opportunities and not less than $88 million in connection with the plaintiffs lost acquisition opportunities. On June 19, 2002, we filed a demurrer in response to the amended complaint on the grounds that the plaintiff
failed to state a claim for fraud, interference with prospective economic advantage, defamation and trade libel. Following a hearing on August 6, 2002, the Court sustained our demurrer on seven of the eight causes of action at issue, including
intentional misrepresentation, promissory fraud, intentional and negligent interference with economic advantage, defamation and trade libel. The Court overruled the demurrer as to one claim against us for fraudulent concealment. If the plaintiff
does not file its second amended complaint by August 29, 2002, then seven claims at issue will be dismissed from the lawsuit. We intend to vigorously defend ourselves against all of the plaintiffs allegations, including the most recent claims.
No estimate of a loss or range of loss upon resolution of the lawsuit can be made at this time.





We may be subject
to various other claims and legal actions arising in the ordinary course of business.





Liquidity and Capital Resources





As of June 30, 2002, cash and cash equivalents were $90.3 million, and working capital was $86.8 million.




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Net cash used in operating activities was $1.4 million for the three months ended
June 30, 2002, compared to $2.7 million for the three months ended June 30, 2001. Cash used in operating activities was primarily due to net losses for the first quarter of fiscal 2002, as well as changes in accounts receivable, accounts payable,
deferred revenue, and accrued expenses. In addition, significant non-cash related adjustments for the three months ended June 30, 2002 and June 30, 2001 included depreciation and amortization of $1.2 million and $1.1 million, respectively, and
stock-based compensation of $1.9 million and $1.1 million, respectively.





Net cash provided by investing
activities was $11.7 million for the three months ended June 30, 2002, compared to $0.7 million used for the three months June 30, 2001. Of the cash provided by investing activities for the three months ended June 30, 2002, $13.5 million was
generated by the proceeds from the sale of short-term investments, which was partially offset by $1.3 million used for purchases of property and equipment. For the three months ended June 30, 2001, of the $0.7 million used in investing activities,
$0.8 million was used for purchases of property and equipment.





Cash provided by financing activities was $1.3
million for the three months ended June 30, 2002, compared to $0.7 million cash used for the three months ended June 30, 2001. Cash provided by financing activities for the three months ended June 30, 2002, consisted of cash received through the
exercise of stock options and shares issued pursuant to the stock purchase plan. In the three months ended June 30, 2001, the cash used was primarily the result of $0.4 million for the repurchase of subsidiary stock and $0.3 million for the
repayment of notes payable to a bank.





As of June 30, 2002, our principal source of liquidity consisted of $90.3
million in cash and cash equivalents. We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next
12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may use cash or need to sell additional equity or debt securities. The sale
of additional equity or convertible debt securities may result in more dilution to our existing stockholders. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.





Recent Accounting Pronouncements





In October 2001, the Financial Accounting Standards Board (FASB) issued SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. While SFAS 144 supersedes SFAS 121, Accounting for Impairment or Disposal of Long-Lived Assets, it retains many of the fundamental provisions of SFAS 121. SFAS 144 also supersedes the accounting and
reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions
(APB 30), for the disposal of a segment of a business. However, it retains the requirement in APB 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. Our adoption of SFAS 144 effective April 1,
2002, did not have a material effect on our condensed consolidated financial statements.





In April 2002, the FASB
issued SFAS 145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections Business Combinations. The provisions of SFAS 145, related to the rescission of SFAS 4, are effective for fiscal
years beginning after May 15, 2002, and the provisions related to SFAS 13 are effective for transactions occurring after May 15, 2002. SFAS 145 rescinds SFAS 4, Reporting Gains and Losses from Extinguishment of Debt, SFAS 64,
Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements, and SFAS 44, Accounting for Intangible Assets of Motor Carriers. SFAS 145 also amends SFAS 13, Accounting for Leases, to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. We do not expect the adoption to have a material impact on our condensed consolidated financial statements.





In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal
Activities, which addresses costs associated with an exit activity (including restructuring) or with disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and
relocating plant facilities and personnel. The provisions of SFAS 146 will not supersede the accounting requirements for costs to restructure operations




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acquired in a business combination. Under SFAS 146, a company will record a liability for a cost associated with an exit or disposal activity
when that liability is incurred and can be measured at fair value. The new requirements are effective prospectively for exit and disposal activities initiated after December 31, 2002. A company may not restate its previously issued financial
statements. SFAS 146 also grandfathers the accounting for liabilities that a company had previously recorded under Emerging Issues Task Force Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit
and Activity (Including Certain Costs Incurred in a Restructuring). We will adopt SFAS 146 effective January 1, 2003 and do not expect the adoption to have a material impact on our condensed consolidated financial statements.





Factors That May Affect Our Results





Except for the quarter ended June 30, 2002, we have a history of losses and an accumulated deficit of approximately $121.6 million as of June 30, 2002. If we do not sustain or increase profitability in the future, we may not be
able to continue to operate.





We have incurred net losses of approximately $121.6 million through June 30,
2002. Although we achieved profitability in the quarter ended June 30, 2002, if we do not sustain or increase profitability in the future at a level expected by securities analysts or investors, the market price of our common stock will likely
decline. If we incur net losses, we may not be able to maintain or increase our number of employees or our investment in capital equipment, sales, marketing, and research and development programs, and we may not be able to continue to operate.





Our limited operating history makes it difficult to evaluate our business and prospects.





We were incorporated in April 1997 and introduced our first principal software product, Blast Fusion, in April 1999. Our business model is
still emerging, and the revenue and income potential of our business and market are unproven. We have a limited history of generating revenue from our software products. As a result of our short operating history, we have limited financial data that
can be used to evaluate our business. Our software products represent a new approach to the challenges presented in the electronic design automation market, which to date has been dominated by established companies with longer operating histories.
Key markets within the electronic design automation industry may fail to adopt our proprietary technologies and software products, or we may not be able to establish distribution channels. Any evaluation of our business and our prospects must be
considered in light of our limited operating history and the risks and uncertainties often encountered by companies in their early stages of development.





Our lengthy sales cycle is unpredictable and can range from three to nine months or more. This lengthy and unpredictable sales cycle makes it difficult for us to forecast revenue and increases the variability of quarterly
fluctuations, which could cause our stock price to decline.





Customers for electronic design automation
software typically commit significant resources to evaluate available software. The complexity of our products requires us to spend substantial time and effort to assist potential customers in evaluating our software tools and in benchmarking our
tools against those of our competitors. Also, because our products require a significant investment of time and cost by our customers, we must target those individuals within the customers organization who are able to make these decisions on
behalf of their companies. These individuals tend to be senior management in an organization, typically at the vice president level. We may face difficulty identifying and establishing contact with such individuals. Even after initial acceptance,
the negotiation and documentation processes can be lengthy. Our sales cycle typically ranges between three and nine months or more. Any delay in completing sales in a particular quarter could cause our operating results to be below expectations.





We have relied and expect to continue to rely on a limited number of customers for a significant portion of our revenue, and our
revenue could decline due to the delay of customer orders or the failure of existing customers to renew licenses.





Our business and financial condition depends on a limited number of customers. In the quarter ended June 30, 2002, two customers accounted for approximately 24% of our revenue, with each of these customers accounting for over 10% of
our total revenue for that period. Four customers accounted for approximately 50% of our revenue in the quarter ended June 30, 2001, with each of these customers accounting for at least 10% of our total revenue for that period.





We expect that we will continue to depend upon a relatively small number of customers for a substantial portion of our revenue
for the foreseeable future. If we fail to successfully sell our products and services to one or more customers in any




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particular period, or a large customer purchases less of our products or services, defers its orders, or fails to renew its relationship with
us, our business and operating results would be harmed.





We license our software products to our customers and
provide technical support. Most of our customers license our software under a three-year licensing agreement. Most of our licensing agreements automatically expire at the end of the term unless the customer renews the license with us or purchases a
perpetual license. As many of our licensing agreements are still within their initial term, we cannot predict what the renewal rate may be. If our customers do not renew their licenses, we may not be able to maintain our current revenue or may not
generate additional revenue. Some of our licensing agreements allow those customers to terminate an agreement prior to its expiration under limited circumstances; for example, if our products do not meet specified performance requirements or goals.
We expect a significant amount of our revenue to be generated from these licensing agreements. If these agreements are terminated prior to expiration or we are unable to collect under these agreements, our revenue may decline.





Because many of our current competitors have pre-existing relationships with our current and potential customers, we might not be able to achieve
sufficient market penetration to achieve or sustain profitability.





Many of our competitors, including Cadence
and Synopsys, have established relationships with our current and potential customers and can devote substantial resources aimed at preventing us from establishing or enhancing our customer relationships. These existing relationships can also make
it difficult for us to obtain additional customers due to the substantial investment that these potential customers have already made in their current design flows. If we are unable to gain additional market share due to these pre-existing
relationships with our potential customers, our operating results could be harmed.





Our quarterly results are difficult to predict,
and if we do not meet quarterly financial expectations, our stock price could decline.





Our quarterly revenue
and operating results are difficult to predict and may fluctuate from quarter to quarter. It is likely that our operating results in some quarters will be below market expectations. If this happens, the market price of our common stock is likely to
decline. Fluctuations in our future quarterly operating results may be caused by many factors, including:





| |  |  | size and timing of customer orders;
| | - |  | -----------------------------------




| |  |  | the structure and mix of our product license agreements;
| | - |  | --------------------------------------------------------




| |  |  | our ability to recognize revenue in a given quarter;
| | - |  | ----------------------------------------------------




| |  |  | the mix of time-based licenses bundled with maintenance, unbundled time-based license agreements and perpetual license agreements;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------




| |  |  | the mix of our license and services revenue agreements;
| | - |  | -------------------------------------------------------




| |  |  | our ability to gain new customers and retain existing customers;
| | - |  | ----------------------------------------------------------------




| |  |  | changes in our pricing policies or those of our competitors;
| | - |  | ------------------------------------------------------------




| |  |  | changes in the level of our operating expenses to support any future growth;
| | - |  | ----------------------------------------------------------------------------




| |  |  | the timing of product releases or upgrades by us or our competitors; and
| | - |  | ------------------------------------------------------------------------




| |  |  | changes in the interpretation of the authoritative literature under which we recognize revenue.
| | - |  | -----------------------------------------------------------------------------------------------




For example, if our competitors change their pricing policies, we may be forced to reduce our pricing or modify our pricing structure in
response. This in turn could cause our quarterly results to differ from those originally anticipated. Also, we base our operating expense levels in part on our expectations of future revenue levels. If revenue for a particular quarter is lower than
we expect, we may be unable to proportionately reduce our operating expenses for that quarter. We also devote substantial resources to obtaining new customers. If we fail to obtain a particular customer order when anticipated, it would harm our
operating results for that quarter.




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Although to date we have focused primarily on bundled time-based license
agreements, we began to enter into perpetual and unbundled time-based license agreements during the quarter ended September 30, 2001. Revenue under these agreements is recognized using the residual method, which typically results in recognition of a
larger amount of revenue in the quarter in which the license is granted as compared to our standard time-based licenses. Our quarterly results will likely fluctuate as a result of the mix of license agreements. We recognize revenue from our bundled
time-based licenses ratably over the term of the agreement, which is typically three years, once the license has been signed and the product delivered. If an arrangement involves extended payment terms, revenue is recognized to the extent of the
lesser of the portion of the fee presently due and payable or the ratable portion of the entire fee.





Our operating results will be
significantly harmed if chip designers do not adopt Blast Fusion.





Blast Fusion has accounted for a
significant majority of our revenue since inception. We believe that revenue from Blast Fusion and related products will account for most of our revenue for the foreseeable future. If integrated circuit designers do not adopt Blast Fusion, our
operating results would be significantly harmed. We must continue market penetration of Blast Fusion to achieve our growth strategy.





Our products are not applicable to all design processes. For example, our products are not applicable to functions such as logic simulation, formal verification or full-feature custom layout editing. Although some of our
customers use front-end products, most of our customers license Blast Fusion to do the physical design step of designing an integrated circuit.





Defects in our products could result in a decrease of customers and revenue, unexpected expenses and loss of competitive market share.





Our products depend on complex software, both internally developed and licensed from third parties. Also, our customers may use our products with other companies products, which also contain
complex software. If the software we provide to customers does not meet performance requirements, our customer relationships may suffer. Complex software often contains errors. Any failure or poor performance of our software or the third party
software with which it is integrated could result in:





| |  |  | delayed market acceptance of our software products;
| | - |  | ---------------------------------------------------




| |  |  | delays in product shipments;
| | - |  | ----------------------------




| |  |  | unexpected expenses and diversion of resources to identify the source of errors or to correct errors;
| | - |  | -----------------------------------------------------------------------------------------------------




| |  |  | damage to our reputation;
| | - |  | -------------------------




| |  |  | delayed or lost revenue; and
| | - |  | ----------------------------




| |  |  | product liability claims.
| | - |  | -------------------------




Our product functions are often critical to our customers, especially because of the resources our customers expend on the design and fabrication of integrated circuits. Our current licensing agreements contain provisions to
provide for a limited warranty, which provides the customer with a right of refund for the license fees if we are unable to correct errors reported during the warranty period. If our contractual limitations are unenforceable in a particular
jurisdiction or if we are exposed to product liability claims that are not covered by insurance, a successful claim could harm our business. We currently do not carry product liability insurance. Also, a limited number of our contracts include
specified ongoing performance criteria. We expect a significant amount of our revenue to be generated from these licensing agreements. If our products fail to meet these criteria, it may lead to termination of these agreements and loss of future
revenue.





Difficulties in developing and achieving market acceptance of new products and delays in planned release dates of our
software products and upgrades may harm our business.





If we fail to develop additional products, our business
and operating results could suffer. We may not have the financial resources necessary to fund future innovations. Also, any revenue that we receive from enhancements or new generations of our proprietary software products may be less than the costs
of development. If we cannot successfully develop and market new products, or if we fail to do so in a timely manner, our reputation and ability to grow our business would suffer.




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A significant portion of our business is conducted internationally. This international concentration
could expose us to risks inherent to doing business internationally that could harm our business. We also intend to expand our international operations. If our revenue from this expansion does not exceed the expenses associated with this expansion,
our business and operating results could suffer.





We generated 31% of our total revenue from sales outside
North America for the quarter ended June 30, 2002. While all of our international sales to date have been denominated in U.S. dollars, our international operating expenses have been denominated in foreign currencies. As a result, a decrease in the
value of the U.S. dollar relative to the foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating margins.





The expansion of our international operations includes the maintenance of sales offices in dispersed locations in Europe, the Middle East, Japan and the Asia-Pacific
region. The Asia-Pacific region includes India, South Korea, Taiwan, Hong Kong and the Peoples Republic of China. If our revenue from international operations does not exceed the expense of establishing and maintaining our international
operations, our business could suffer. Additional risks we face in conducting business internationally include:





| |  |  | difficulties and costs of staffing and managing international operations across different geographic areas;
| | - |  | -----------------------------------------------------------------------------------------------------------




| |  |  | changes in currency exchange rates and controls;
| | - |  | ------------------------------------------------




| |  |  | unexpected changes in regulatory requirements that impose multiple conflicting tax laws and regulations;
| | - |  | --------------------------------------------------------------------------------------------------------




| |  |  | the possible lack of financial and political stability in foreign countries that prevent overseas sales growth; and
| | - |  | -------------------------------------------------------------------------------------------------------------------




| |  |  | the effects of the terrorist attacks in the United States and any related conflicts or similar events worldwide.
| | - |  | ----------------------------------------------------------------------------------------------------------------




Future changes in accounting standards, specifically changes affecting revenue recognition, could cause adverse unexpected revenue fluctuations.





Future changes in accounting standards, specifically those affecting software revenue recognition, could
require us to change our methods of revenue recognition. These changes could result in deferral of revenue recognized in current periods to subsequent periods or accelerated recognition of deferred revenue to current periods, each of which could
cause shortfalls in meeting the expectations of investors and securities analysts. Our stock price could decline as a result of any shortfall.





Our future success will depend on our ability to keep pace with the rapidly evolving technology standards of the semiconductor industry. If we are unable to keep pace with rapidly changing technology standards, our products could
be rendered obsolete, which would cause our operating results to decline.





The semiconductor industry has made
significant technological advances. In particular, recent advances in deep submicron technology have required electronic design automation companies to continuously develop new products and enhance existing products. The evolving nature of our
industry could render our existing products and services obsolete. Our success will depend, in part, on our ability to:





| |  |  | enhance our existing products and services;
| | - |  | -------------------------------------------




| |  |  | develop and introduce new products and services on a timely and cost-effective basis that will keep pace with technological developments and evolving industry
standards; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | address the increasingly sophisticated needs of our customers.
| | - |  | --------------------------------------------------------------




If we are unable, for technical, legal, financial or other reasons, to respond in a timely manner to changing market conditions or customer requirements, our business and
operating results could be seriously harmed.





We may not be able to hire the number of engineering personnel required by our
customers, which would harm our ability to achieve our growth strategy. Also, because competition for qualified personnel is intense in our industry, we may not be able to recruit necessary personnel, which could impact the development or sales of
our products.





We have experienced, and may continue to experience, difficulty in hiring and retaining highly
skilled engineers with appropriate qualifications to support our growth strategy. Our success depends on our ability to identify, hire, train and retain




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qualified engineering personnel with experience in integrated circuit design. Specifically, we need to attract and retain field application
engineers to work with our direct sales force to technically qualify new sales opportunities and perform design work to demonstrate our products capabilities to customers during the benchmark evaluation process. Competition for qualified
engineers is intense, particularly in the Silicon Valley where our headquarters are located. If we lose the services of a significant number of our engineers or we cannot hire additional engineers, we will be unable to increase our sales or
implement or maintain our growth strategy.





Our success will also depend on our ability to attract and retain
senior management, sales, marketing and other key personnel. Because of the intense competition for such personnel, it is possible that we will fail to retain our key technical and managerial personnel. If we are unable to retain our existing
personnel, or attract and train additional qualified personnel, our growth may be limited due to our lack of capacity to develop and market our products. This could harm the markets perception of our business and our ability to achieve our
business goals.





Our success is highly dependent on the technical, sales, marketing and managerial contributions of key individuals,
and we may be unable to recruit and retain these personnel.





Rajeev Madhavan, our chief executive officer, Roy
E. Jewell, our president and chief operating officer, and Hamid Savoj, our vice presidentproduct development, as well as our research and development, sales and marketing personnel, are critical to our business. We do not have long-term
employment agreements with our key employees, and we do not maintain any key person life insurance policies. If we lose the services of any of these key executives, our product development processes and sales efforts could be slowed. We may also
incur increased operating expenses and be required to divert the attention of other senior executives to search for their replacements. The integration of our new executives or any new personnel could disrupt our ongoing operations.





If we fail to maintain competitive stock option packages for our employees, or if our stock declines materially for a protracted period of time, we
might have difficulty retaining our employees and our business may be harmed.





In todays competitive
technology industry, employment decisions of highly skilled personnel are influenced by stock option packages, which offer incentives above traditional compensation only where there is a consistent, long-term upward trend over time of a
companys stock price. If our stock price declines due to market conditions, investors perceptions of the technology industry or managerial or performance problems we have, our stock option incentives may lose value to key employees, and
we may lose these employees or be forced to grant additional options to retain them. This in turn could result in:





| |  |  | immediate and substantial dilution to investors resulting from the grant of additional options necessary to retain employees; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------




| |  |  | potential compensation charges against the company, which could negatively impact our operating results.
| | - |  | --------------------------------------------------------------------------------------------------------




Our growth places a significant strain on our management systems and resources, and if we fail to manage this growth, our business will be harmed.





The growth that we have experienced has placed a significant strain on our management, administrative and
financial resources. We have also significantly expanded our operations in the United States and internationally, and we plan to continue to expand the geographic scope of our operations. To manage our growth, we must implement and improve
additional and existing administrative, financial and operations systems, procedures and controls. Our failure to manage growth could delay execution of our business plan or disrupt our operations. We believe we have sufficient office space to meet
our current needs.





We intend to further penetrate the customer-owned tooling market. If we cannot successfully penetrate this market
or manage the costs associated with penetrating this market, our operating results may suffer.





We continue to
broaden the focus of our sales efforts to include customer-owned tooling companies, which are companies that both design the logic and implement the physical design of an integrated circuit. Once the chip is designed, the customer-owned tooling
company contracts with a foundry that will manufacture the chip based on a mask owned and provided to the foundry by the company. Customer-owned tooling companies tend to be smaller companies than our initial customers and may require fewer licenses
from us. We have limited experience with these types of customers, and the costs




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associated with obtaining these customers may increase our operating expenses. If we cannot successfully penetrate the customer-owned tooling market or successfully manage the costs associated
with obtaining customers in this market, our business and operating results may suffer.





We have incurred high customer engagement and
support costs, and the failure to manage these costs could harm our operating results.





Because of the
complexity of our products, we typically incur substantial costs when engaging a new customer. We also incur high field application engineering support costs to assist customers in their evaluations of our products. In the past, we have also
provided substantial sales commission incentives to encourage and reward our sales employees for obtaining customer license agreements. If we fail to manage our customer engagement and support costs or the costs associated with our commission
incentives, our operating results could suffer. We also expect sales and marketing expense to increase in absolute dollars as we intensify our sales efforts. Our sales and marketing activities may not yield increased revenue and, even if they do,
any increased revenue may not offset the expenses we incur.





Our gross margin may decrease if we incur higher than expected costs
associated with providing design and support services.





Our gross margin depends in part on the costs we incur
in providing design and support services. For example, increased demand by our customers for design and support services may negatively impact our gross margins because of the increased costs of providing design services and costs associated with
attracting and retaining the requisite engineering resources to provide these services. Our gross margin may decrease if we are unable to manage support costs associated with new license agreements or the mix of license and services revenue we
generate. Also, it is difficult to predict the cost and schedule of the support required under our license or design agreements because of the technical nature of the work to be performed under those contracts. We may enter into contracts that prove
to be technically unfeasible or may result in losses because the cost of resources to complete the agreement exceeds the contract price. Failure by us to perform under the terms of our agreements may cause us to lose customers and revenue.





We may have difficulty assimilating technology, personnel and operations from any future acquisitions, and these difficulties may
disrupt our business and divert managements attention.





The Moscape merger is our only merger to date,
and we have discontinued the development, marketing and licensing of Moscapes CircuitScope product line and have also discontinued the marketing and licensing of GateScope as a separate product. We may pursue other acquisitions that we believe
may complement our business. If we do acquire additional companies, the integration of the separate operations of our company and an acquisition partner may result in problems related to integration of technology and management teams, either of
which could divert managements attention from the day-to-day operations of the combined company. Also, we may not be able to retain key management, technical and sales personnel after an acquisition. We may not realize all of the anticipated
benefits of future acquisitions.





Our products incorporate software licensed from third parties, and if we lose or are unable to
maintain any of these software licenses, our product shipments could be delayed or reduced.





We use software,
such as front-end language processing, license keying software and schematic viewing software, which we license from third parties. We have also licensed the rights to some technologies from various universities, including the Technical University
of Eindhoven, Delft University and the University of California at Berkeley. These third-party software licenses may not continue to be available on commercially reasonable terms, or at all. If we cannot maintain existing third party technology
licenses or enter into licenses for other existing or future technologies needed for our products, we could be required to cease or delay product shipments while we seek to develop alternative technologies.





If chip designers and manufacturers do not integrate our software into existing design flows, or if other software companies do not cooperate in working with
us to interface our products with their design flows, demand for our products may decrease.





To successfully
implement our business strategy, we must provide products that can interface with the software of other electronic design automation software companies. Our competitors may not support our or our customers efforts to integrate our products
into their existing design flows. We must develop cooperative relationships with competitors so that they will work with us to integrate our software into a customers design flow. Currently, our software is designed to interface with the




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existing software of Avant!, Cadence, Synopsys and others. If we are unable to convince customers to adopt our software products over those of competitors offering a broader set of products, or
if we are unable to convince other semiconductor companies to work with us to interface our software with theirs to meet the demands of chip designers and manufacturers, our business and operating results will suffer.





We may not obtain sufficient patent protection, which could harm our competitive position and increase our expenses.





Our success and ability to compete depends to a significant degree upon the protection of our software and other proprietary technology.
Currently, five of our patent applications have been allowed and we have 11 patent applications pending in the United States, including one provisional patent application. These legal protections afford only limited protection for our technology,
and the rights that may be granted under any future patents that may be issued may not provide competitive advantages to us. Patent protection in foreign countries may be limited or unavailable where we need this protection. It is possible that:





| |  |  | our pending patent applications may not be issued;
| | - |  | --------------------------------------------------




| |  |  | competitors may independently develop similar technologies or design around our patents;
| | - |  | ----------------------------------------------------------------------------------------




| |  |  | patents issued to us may not be broad enough to protect our proprietary rights; and
| | - |  | -----------------------------------------------------------------------------------




| |  |  | any issued patent could be successfully challenged.
| | - |  | ---------------------------------------------------




We rely on trademark, copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and if these rights are not sufficiently protected, it could harm our ability to compete and generate
revenue.





We also rely on a combination of trademark, copyright and trade secret laws, and contractual
restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. Our ability to compete and grow our business could suffer if these rights are not adequately protected. We seek to protect our source
code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to agreements, which impose certain restrictions on the licensees ability to utilize the software. We also
seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. Our proprietary rights may not be adequately protected because:





| |  |  | laws and contractual restrictions may not prevent misappropriation of our technologies or deter others from developing similar technologies; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this
unauthorized use.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Also, the laws of other countries in which we market our products may offer
little or no protection of our proprietary technologies. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for it, which
would harm our competitive position and market share.





We may face intellectual property infringement or other claims against us or
our customers that could be costly to defend and result in our loss of significant rights.





Many of our
contracts contain provisions indemnifying our customers from third party intellectual property infringement claims. Other parties may assert intellectual property infringement claims against us or our customers, and our products may infringe the
intellectual property rights of third parties. If we become involved in litigation, we could lose our proprietary rights and incur substantial unexpected operating costs. Intellectual property litigation is expensive and time-consuming and could
divert managements attention from our business. If there is a successful claim of infringement, we may be required to develop non-infringing technology or enter into royalty or license agreements, which may not be available on acceptable
terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis would harm our business. Our products may infringe third-party patents that may relate to our products. Also, we may be unaware
of filed patent applications that relate to our software products.




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We may also become involved in litigation unrelated to intellectual property
infringement claims. For example, in August 2001, a complaint was filed against us alleging breach of contract, among other things. A more detailed description of this litigation appears under the heading Legal Proceedings. We may not be
successful in defending this or other claims. Regardless of the outcome, litigation can result in substantial expense and could divert the efforts of our management and technical personnel.





We compete against companies that hold a large share of the electronic design automation market. If we cannot compete successfully, we will be unable to gain market share.





We currently compete with companies that hold dominant shares in the electronic design automation market,
such as Cadence and Synopsys. These companies are continuing to broaden their product lines to provide an integrated design flow. Each of these companies has a longer operating history and significantly greater financial, technical and marketing
resources, as well as greater name recognition and larger installed customer bases than we do. Our competitors are better able to offer aggressive discounts on their products, a practice that they often employ. Our competitors offer a more
comprehensive range of products than we do and they are often able to respond more quickly or price more effectively to take advantage of new opportunities or customer requirements. Further consolidation in the electronic design automation market
could result in an increasingly competitive environment. Competitive pressures may prevent us from obtaining market share, require us to reduce the price of products and services or cause us to lose existing customers, which could harm our business.
Our competitors have a significant market presence in North America. To successfully execute our business strategy, we must continue to increase our sales in North America. If we fail to do so in a timely manner or at all, we may not be able to gain
market share and our business and operating results could suffer.





Also, a variety of small companies continue to
emerge, developing and introducing new products. Any of these companies could become a significant competitor in the future. We also compete with the internal chip design automation development groups of our existing and potential customers.
Therefore, these customers may not require, or may be reluctant to purchase, products offered by independent vendors.





Our competitors may announce new products or technologies that have the potential to replace our existing or new product offerings. The introduction of these new products by competitors may cause potential customers to defer
purchases of our products. If we fail to compete successfully, we will not gain market share and our business will fail.





If the
industries into which we sell our products experience recession or other cyclical effects impacting our customers research and development budgets, our operating results could be negatively impacted.





Demand for our products is driven by new integrated circuit design projects. The demand from semiconductor and system companies is
uncertain and difficult to predict. Slower growth in the semiconductor and systems industries, a reduced number of design starts, reduction of electronic design automation budgets or continued consolidation among our customers would harm our
business and financial condition.





The primary customers for our products are companies in the communications,
computing, consumer electronics, networking and semiconductor industries. Any significant downturn in our customers markets, in particular, or in general economic conditions which result in the cutback of research and development budgets or
the delay of software purchases would likely result in a reduction in demand for our products and services and could harm our business. For example, the United States economy, including the semiconductor industry, is currently experiencing a
slowdown, which has negatively impacted our business and operating results. Terrorist attacks in the United States and other worldwide events throughout the Middle East have increased uncertainty in the United States economy. If the economy
continues to decline as a result of the recent economic, political and social turmoil, existing customers may delay their implementation of our software products and prospective customers may decide not to adopt our software products, either of
which could negatively impact our business and operating results.





In addition, the markets for semiconductor
products are cyclical. In recent years, some Asian countries have experienced significant economic difficulties, including devaluation and instability, business failures and a depressed business environment. These difficulties triggered a
significant downturn in the semiconductor market, resulting in reduced budgets for chip design tools, which, in turn, negatively impacted us. In addition, the electronics industry has historically been subject to seasonal and cyclical fluctuations
in demand for its products, and this trend may continue in the future. These




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industry downturns have been, and may continue to be, characterized by diminished product demand, excess manufacturing capacity and subsequent erosion of average selling prices.





Our directors, executive officers and principal stockholders own a substantial portion of our common stock and this concentration of ownership may
allow them to elect most of our directors and could delay or prevent a change in control of Magma.





Our
directors, executive officers and stockholders who currently own over 5% of our common stock collectively beneficially own a substantial portion of our outstanding common stock. These stockholders, if they vote together, will be able to
significantly influence all matters requiring stockholder approval. For example, they may be able to elect most of our directors, delay or prevent a transaction in which stockholders might receive a premium over the market price for their shares or
prevent changes in control or management.





Our stock price may decline significantly because of stock market fluctuations that affect
the prices of technology stocks. A decline in our stock price could result in securities class action litigation against us, that could divert managements attention and harm our business.





The stock market has experienced significant price and volume fluctuations that have adversely affected the market prices of common stock
of technology companies. These broad market fluctuations may reduce the market price of our common stock. In the past, securities class action litigation has often been brought against a company after periods of volatility in the market price of
securities. We may in the future be a target of similar litigation. Securities litigation could result in substantial costs and divert managements attention and resources, which could harm our ability to execute our business plan.





We may need additional capital and if funds are not available on acceptable terms, we may not be able to hire and retain employees,
fund our expansion or compete effectively.





We believe that our existing capital resources will enable us to
maintain our operations for at least the next 12 months. However, if our capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated. This financing may not be available in
sufficient amounts or on terms acceptable to us and may be dilutive to existing stockholders. If adequate funds are not available or are not available on acceptable terms, our ability to hire, train or retain employees, to fund our expansion, take
advantage of unanticipated opportunities, develop or enhance services or products, or respond to competitive pressures would be significantly limited.





Our certificate of incorporation, bylaws and Delaware corporate law contain anti-takeover provisions which could delay or prevent a change in control even if the change in control would be beneficial to our stockholders.





Delaware law, as well as our certificate of incorporation and bylaws, contain anti-takeover provisions that
could delay or prevent a change in control of our company, even if it were beneficial to the stockholders to do so. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. These
provisions:





| |  |  | authorize the issuance of preferred stock that can be created and issued by the Board of Directors without prior stockholder approval to increase the number of
outstanding shares and deter or prevent a takeover attempt;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------




| |  |  | establish a classified Board of Directors requiring that not all members of the board be elected at one time;
| | - |  | -------------------------------------------------------------------------------------------------------------




| |  |  | prohibit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | limit the ability of stockholders to call special meetings of stockholders; and
| | - |  | -------------------------------------------------------------------------------




| |  |  | establish advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted upon by stockholders at
stockholder meetings.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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In addition, Section 203 of the Delaware General Corporation Law and the terms of
our stock option plans may discourage, delay or prevent a change in control of our company. Specifically, Section 203 prohibits a Delaware corporation from engaging in any business combination with an interested stockholder for three years after the
date the stockholder became an interested stockholder unless specific conditions are met. Also, our stock option plans include change in control provisions that allow us to grant options or stock purchase rights that will become vested immediately
upon a change in control of us.





Item 3:Quantitative and Qualitative Disclosures About Market Risk





Interest Rate Risk





Our exposure to market risks for changes in interest rates relates
primarily to our investment portfolio. As of June 30, 2002, our cash and investment portfolio consisted of money market funds and other high-grade investments with maturities of less than 90 day. Due to the short-term nature of our investment
portfolio, an immediate 10% increase in interest rates would not have a material effect on the fair market value of our portfolio. Since we have the ability to liquidate this portfolio, we do not expect our operating results or cash flows to be
materially affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio.





Foreign Currency Exchange Risk





We transact some portions of our business in various
foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to operating expenses in the United Kingdom, Europe and Japan, which are denominated in the
respective local currency. As of June 30, 2002, we had no hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses in the United Kingdom and Japan denominated in the respective local currency. We
assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.




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PART II:    OTHER INFORMATION





Item 1:Legal Proceedings





We are a defendant in a lawsuit alleging breach of
contract, fraud and deceit, unfair business practices and intentional interference with prospective economic advantage arising out of an OEM distribution agreement. The complaint, filed in August 2001, seeks damages of $3.15 million as well as other
damages from any gains, profits and advantages lost and punitive damages. We filed a cross-complaint against the plaintiff in December 2001, alleging breach of contract, breach of implied covenant of good faith and fair dealing, breach of express
warranty and negligent misrepresentation. On May 15, 2002, the plaintiff amended its complaint to include allegations of defamation, trade libel, and intentional and negligent interference with prospective economic advantage. These allegations are
brought against us, our Chief Executive Officer, and other Doe defendants. In addition, the plaintiffs amended complaint adds allegations of promissory fraud and concealment to the claims against us. In addition to the damages
sought in connection with the original complaint, the amended complaint seeks damages of not less than $14.7 million in connection with the plaintiffs lost sales and services opportunities and not less than $88 million in connection with the
plaintiffs lost acquisition opportunities. On June 19, 2002, we filed a demurrer in response to the amended complaint on the grounds that the plaintiff failed to state a claim for fraud, interference with prospective economic advantage,
defamation and trade libel. Following a hearing on August 6, 2002, the Court sustained the our demurrer on seven of the eight causes of action at issue, including intentional misrepresentation, promissory fraud, intentional and negligent
interference with economic advantage, defamation and trade libel. The Court overruled the demurrer as to one claim against us for fraudulent concealment. If the plaintiff does not file its second amended complaint by August 29, 2002, then seven
claims at issue will be dismissed from the lawsuit. We intend to vigorously defend ourselves against all of the plaintiffs allegations, including the most recent claims. No estimate of a loss or range of loss upon resolution of the lawsuit can
be made at this time.





We may be subject to various other claims and legal actions arising in the ordinary course
of business.





Item 5:Other Information





The Company has been advised by Rajeev Madhavan, its
Chief Executive Officer and Chairman of the Board, that the Madhavan Living Trust, of which Mr. Madhavan and his spouse, Geetha Madhavan, are co-trustees, amended its Rule 10b5-1 Sales Plan with Goldman Sachs & Co., effective as of July 29,
2002.





Item 6:Exhibits and Reports on Form 8-K





(a)    Exhibits.





Exhibit Number

Exhibit Description2.2

Second Amended and Restated Agreement and Plan of Reorganization, dated July 7, 2000, between the Company, Magma
Acquisition Corp. and Moscape, Inc. (incorporated by reference to the exhibit of the same number to the Companys Registration Statement on Form S-1 (File No. 333-60838)).3.1

Amended and Restated Certificate of Incorporation (incorporated by reference to the exhibit of the same number to
the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).3.2

Certificate of Correction to Amended and Restated Certificate of Incorporation (incorporated by reference to the
exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).3.3

Amended and Restated Bylaws (incorporated by reference to the exhibit of the same number to the Companys Form
10-K for the year ended March 31, 2002 filed on June 28, 2002).4.1

Form of Common Stock Certificate (incorporated by reference to the exhibit of the same number to Amendment No. 6 to
the Companys Registration Statement on Form S-1 (File No. 333-60838)).4.2

Amended and Restated Investors Rights Agreement, dated July 31, 2001, by and among the Companys and the
parties who are signatories thereto (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).




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(b)    Reports on Form 8-K.





The Company did not file any reports on Form 8-K with the Securities and Exchange Commission during the quarter ended June 30, 2002.




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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.








MAGMA DESIGN AUTOMATION, INC.By:

/s/    ROBERT
SHEFFIELDRobert Sheffield Vice
President Finance and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Signatory)





Dated:    August 13, 2002




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EXHIBIT INDEX


TO


MAGMA DESIGN
AUTOMATION, INC.





Quarterly Report on Form 10-Q


For the Quarter ended June 30, 2002





Exhibit Number

Exhibit Description2.2

Second Amended and Restated Agreement and Plan of Reorganization, dated July 7, 2000, between the Company, Magma
Acquisition Corp. and Moscape, Inc. (incorporated by reference to the exhibit of the same number to the Companys Registration Statement on Form S-1 (File No. 333-60838)).3.1

Amended and Restated Certificate of Incorporation (incorporated by reference to the exhibit of the same number to
the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).3.2

Certificate of Correction to Amended and Restated Certificate of Incorporation (incorporated by reference to the
exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).3.3

Amended and Restated Bylaws (incorporated by reference to the exhibit of the same number to the Companys Form
10-K for the year ended March 31, 2002 filed on June 28, 2002).4.1

Form of Common Stock Certificate (incorporated by reference to the exhibit of the same number to Amendment No. 6 to
the Companys Registration Statement on Form S-1 (File No. 333-60838)).4.2

Amended and Restated Investors Rights Agreement, dated July 31, 2001, by and among the Company and the parties
who are signatories thereto (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).




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